EMI backs $4.7 billion offer from Terra Firma

DavidB. Wilkerson

LONDON (MarketWatch) -- Record label EMI Group on Monday said it is recommending an offer of 2.4 billion pounds ($4.7 billion) from British private-equity house Terra Firma, with the bid coming on the same day the recorded music group reported a 264 million pound annual loss.

EMI (EMI) said it is recommending the offer valued at 265 pence a share, which is at a 19% premium to when it announced Warner Music had made a takeover offer.

Shares of EMI surged 9.2% to 273 pence, possibly on hopes that Warner Music
WMG, +11.76%
would come back with a sweetened offer.

Warner Music shares were down marginally at $17.31.

"Terra Firma's objective is to build on EMI's current position as one of the world's leading music companies and accelerate the development of its digital and online strategy to fully exploit this long-term growth opportunity," said Guy Hands, Terra Firma's chief executive.

John Gildersleeve, chairman of EMI, said the company received "several" proposals, but that the Terra Firma offer delivers cash now without regulatory uncertainty.

That statement is a clear reference to Warner Music's interest, as the European Union is reviewing a decision to clear a venture between Sony and Bertelsmann on competition grounds.

Gildersleeve said it is important for EMI to go private now while it tries to adapt to a changing environment.

"The global music industry is undergoing significant change, and while EMI is confident in its ability to deliver its recently announced restructuring plans, significant uncertainty exists as to the timing and extent of future market developments," he said in a statement.

EMI hurried out its earnings two days early due to the takeover bid, and the report underlines the struggles it has had.

EMI swung to a 264 million pound loss in the fiscal year ended March 31, with revenue falling 16% to 1.75 billion pounds.

The company, home to artists including Kylie Minogue and Lenny Kravitz, said the recorded music market continues to undergo significant change, with sales dropping more quickly than the industry anticipated.

Good news for Warner Music?

One analyst said that although Warner Music has apparently been unsuccessful in acquiring EMI, a combined Warner-EMI entity would be overvalued anyway, and that declining fundamentals in the music business would have called into question the wisdom of such a purchase.

Richard Greenfield of Pali Research said a combined Warner Music-EMI entity, assuming Warner Music's buyout offer of 260 pence per share, would trade at about 11.5 times his 2008 earnings before interest, depreciation and amortization estimate.

"We would not view that as compelling valuation," Greenfield told clients Monday, "given the prospect of declining industry revenue growth over the next 24 months."

The music industry has suffered as sales of compact discs have been dropping steadily over the past several years. Digital music distribution, which many consumers have preferred since the advent of music-sharing services such as Napster popped up in the late 1990s, has soared in popularity thanks to Apple Computer's iPod and other MP3 players. However, 99-cent digital music downloads are nowhere near as lucrative for the record companies as CDs had been, as the discs had sold for $15 a piece, or in the $25-$30 range for two-CD sets.

"[W]e truly do not understand the attraction of EMI's business, particularly given the growing risk to mechanical royalties as industry unit sales are declining far faster than expected," Greenfield wrote.

Greenfield said Warner Music will now have to operate as a standalone company "longer than it wants, ending hopes of greater cost cuts to mitigate organic margin declines."

However, Laura Martin of Soleil/Media Metrics, who recently reiterated her buy rating on Warner Music following the company's release of first-quarter earnings earlier this month, says consensus growth rates for the worldwide global music business are too low, and that the company's "operating managers are excellent."

One factor that should help music companies such as Warner Music is that its music library will increase in value as online services continue to gain traction with consumers, Martin said in her recent note. Such services tend to have as many as 1 million songs available for purchase, far more than were available at music superstores and other brick-and-mortar retail outlets in years past.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.